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To: Proud_Infidel who wrote (37960)	10/7/2000 8:33:02 PM
From: Ian@SI	Read Replies (2) \| Respond to of 70976

Brian, I'm not an expert in Leaps but before trying the strategy, one should find out whether the contracts are American Style or European Style. My guess would be the former which means that the seller of the PUTs could take an early assignment at any point in time. As I suspect that those leaps would be almost totally illiquid, early assignment is a very real possibility especially should the holder of the contract fear or foresee a rise in the price of the underlying. While the premium is the seller's to keep, the interest may never be realized; and selling 10 Contracts of Jan 2003 130s may result in 1000 shares being exchanged for $130K without any notice whatsoever. And if AMAT reaches the previous cycle low, the PUT seller may only realize $20K if forced to sell to pay the freight. And a 10% Bid/ask spread is not uncommon with illiquid options; so the profit may well be reduced if the options don't ultimately expire worthless. And 2003 is the current view for the end of this upleg. I'm also interested in what Tito has to say; but the strategy sounds like it may have a higher risk than the lurker thinks. Ian.

To: Proud_Infidel who wrote (37960)	10/8/2000 11:12:35 AM
From: Sam Citron	Read Replies (1) \| Respond to of 70976

RE: Shorting Put Leaps I have written naked puts, including LEAPS, though never as deep in the money [DIM] as suggested by lurker. Currently I'm short some Intel Jan '03 40 puts, which, I am unhappy to report, have just gone slightly in the money. First of all, as Ian suggested, yes, these are "American style options", hence they may be exercised at any time by the opposite party who is long the put. Lurker's idea is intriguing since the income generated from selling DIM puts is much greater. OTOH, the time premium that the seller of DIM puts realizes is typically much less. For example, let's compare the AMAT Jan '03 50 put to the AMAT Jan '03 130 put: The 50 is trading around 14, so with the stock at 54, the time premium is 18 [check: 50-14=36=breakeven=18 below 54 PV of AMAT]. However the 130 is trading at about 76 (with wide spread as noted by Ian) hence time premium is nil. So there's the tradeoff: The DIM put writer trades income for time premium. And I would argue that this income stream is rather uncertain, for the reason that Ian mentions, i.e., the risk of exercise. Although the conventional wisdom is that puts are rarely exercised early, the reason for this is that to exercise the puts usually costs the put buyer time premium. Where there is no time premium, there is no disincentive to early exercise. I would argue that the income inclined AMAT bull would be better off writing the Jan '03 50 put instead of the 130. It is true that he would only collect a premium of $1,400 per contract, rather than $7,600 for the 130 strike. However, the 50 put writer has lowered his breakeven price from 54 to 36. I would reason that even if AMAT were to get down to such a depressed level, it would probably not stay down there for long. The leap put write thus serves a double function for me: (1) it generates a moderate amount of income in return for taking a tolerable amount of risk and (2) it enforces a discipline that forces me to be prepared to buy on an extreme dip, which may be psychologically difficult to do ordinarily. I often rationalize it as being paid an income stream in return for entering a ridiculously low limit buy order that is non-cancelable. I especially like knowing that my breakeven price is x% below the current market price. That said, my naked put writing experience is somewhat limited, and I am sure that one day I will pay some tuition on it. <G> One final point. Lurker mentioned a margin requirement of 20% in equity. I believe there is also a maintenance margin requirement of 50% of the current value of the stock. This becomes important if you are trying to maximize the margin potential of your account. Often it creates an incentive for the put writer to liquidate a favorable position early rather than simply waiting for it to expire worthless, because this maintenence margin is seemingly unfairly linked strictly to the price of the stock, even though there may be very little time left on it and it may be way out of the money. Hope this is not too confusing and that it answers more questions than it raises. Sam

To: Proud_Infidel who wrote (37960)	10/8/2000 2:24:07 PM
From: Stu E.	Read Replies (1) \| Respond to of 70976

I have sold put leaps in numerous tech stocks where I had the strength of my convictions that the fundamental story of the underlying security was bullish. My preference is out of the money puts. I've been successful over the past three years selling leap puts in EMC, LSI, SEG, and IDTI. There is, nevertheless, great risk of assignment to the seller of puts. I would suggest the risk/reward is much better if you are considering selling AMAT puts, for example, to consider selling the put at a strike price at least 20% below the current price of the stock. You receive a considerable amount for the time premium while enjoying some protection in the event that you are wrong and the stock declines.

To: Proud_Infidel who wrote (37960)	10/9/2000 12:13:18 PM
From: Sam Citron	Read Replies (1) \| Respond to of 70976

RE: Deep in the money puts Final Thoughts Received this PM from a lurker who gave me permission to post: RE: Shorting Put Leaps I am forced to be a lurker on this board. To post would be inappropriate, even if the issue is off topic, such as this one on option strategy. However, people should be aware of the issues surrounding deep in the money (DITM) puts. I have used them several times for short term loans. However, that is exactly how they should be treated. Remember, most option models, and many of them are very accurate, consider the arbitrage opportunities in determining the relative value of Puts and Calls. A synthetic long position can be created with a long Call and a short Put. If a trader can short a stock and earn the interest on the money received while being flat the position by also owning a synthetic long, he/she would do so in large numbers. (This position is known as a "Reverse Conversion") Calls are always priced more expensively than Puts to cover this possibility. The Call will nominally be more expensive by the same amount that the trader would earn in interest at a risk free (US government) interest rate, over the period until expiration. For strike prices near the money, this is almost always exactly true. However, this model falls apart as the strike prices are significantly above the market price of the underlying. When this occurs, the price of the Put should decline below parity. With American style options, this cannot occur, because they would immediately be bought and exercised by someone with low transaction costs. Therefore, the Put is overvalued when it is far out of the money. This creates the “interest arbitrage” that the “lurker” is discussing taking advantage of. Any DITM Puts that are outstanding are owned by people that are not aware of (or not paying attention to) the true cost of owning them. Maybe someone bought them when they were near the money and they are still holding them out of ignorance. Early exercise is always going to occur with a professional trader. If you watch the Volume and Open Interest for a deep in the money Put, you will see that they are very out of sync. There may be long periods where there is no Volume, but the Open Interest slowly drops. These are indications of early exercise. Other times, there is Volume, but the next day, the open interest has not changed. This is likely to be a professional trader took the buy side of the trade to make the market, bought the stock and did an early exercise. With low transaction costs, this will leave them with a small profit. Meanwhile, the trader that sold the Puts is enjoying his/her “free interest income”. However, someone got an early exercise. Remember, all options are cleared via the Options Clearing Corporation (OCC). There is no 1 to 1 relationship between the buyer and seller of an option. Once a transaction has occurred, the new contract(s) is just another entry in the “open Interest” for the option. When a contract is exercised, one of the clearing houses that represents sellers of these contracts is selected (lottery, so they say) for exercise. How an individual is selected within each clearing house is up to the clearing house. Lottery is an option, but not required. (Read that, small fish, watch out…) So, in the example given, if someone sells 10 Jan 03 AMAT Puts, VPJMF, for 75 ¾ and, since this is an interest play, he might as well also short AMAT at 54 3/16. He will have received 129 15/16 in cash for an obligation to buy AMAT back for 130 in January 2003. In this example, if it can be executed, he/she is risking 1/16, that’s $62.50 plus commissions for a total cost of $100 to $150, for the use of $130,000 for over 27 months. Not a bad interest rate! However, most likely, when this trader sold the 10 contracts, 10 contracts were also exercised by the professional trader on the buy side. With the lottery method, it is unlikely that the writer of these new options is the one selected for early exercise. So he/she has a free ride for a while, until someone else discovers the method, sells a few contracts and the lottery comes up with their name on it. Sorry to ramble on, but to expect more than short term use of the funds is dangerous. Eventually, the Open Interest on DITM Puts drifts toward zero.